Government Deficits and Inflation: Separating Fact from Fiction

Former Global Chief Economist for JPMorgan Chase (Ph.D. in Economics) & Current BrightQuery Chief Economist

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The relationship between the U.S. federal budget deficit and U.S. inflation has been a persistent topic of debate among consumers and political commentators. A prevalent argument suggests that substantial government deficits are responsible for the increased inflation rates we are experiencing today. However, a nonpartisan data review reveals that the correlation between the personal consumption expenditures (PCE) deflator—the Federal Reserve’s policy metric for inflation—is only 4.7%. This figure is nearly statistically insignificant and too low to conclude that the recent high budget deficit of -6.3 as a percentage of U.S. GDP (2024) was the primary cause of ongoing inflation throughout 2024 and into 2025. Of course, most Republicans and Democrats, as well as Fed Chair Powell, have agreed that the current high federal government deficits are unsustainable and excessive during a healthy economic expansion.

Taking a Closer Look at the Data

A meticulous review of historical examples further illustrates the weak link between budget deficits and inflation. The PCE inflation rate surged to 10.4% in 1974, while the federal budget deficit was only -0.4. Similarly, the PCE inflation rate spiked to 10.7% in 1980, with the deficit at -2.6. If federal deficits were a significant factor in determining inflation, one would expect a stronger relationship between these variables. Since 1950, data shows that other factors, such as oil shocks, geopolitical developments, monetary policy decisions, and supply chain disruptions, have impacted inflation more than U.S. budget deficits!

While it may be tempting to argue that the price of U.S. eggs is rising due to last year’s high U.S. deficits, the facts reveal that over 20 million egg-laying chickens perished during the fourth quarter of 2024 alone due to bird flu. That reduced the supply of eggs, which explains the parabolic rise in egg prices! I will leave it to the reader to decide whether sitting Presidents should be blamed for flu pandemics during their watch.

Source: U.S. Office of Management & Budget and the U.S. Bureau of Economic Analysis

What Happened in 2024?

Although the significant deficit in 2024 has raised concerns about wasteful government spending and inefficiencies, it is crucial not to confuse the relationship between government deficits and inflation. While increased government spending can enhance economic demand, potentially contributing to inflationary pressures, the degree of this effect varies based on the level of slack in the economy, monetary policy, supply chain disruptions, and various geopolitical factors.

One area of legitimate concern regarding government spending is inefficiency and fraud. The Office of Deficit Oversight and Government Efficiency (DOGE), headed by Elon Musk, recently highlighted a September 2024 report from the U.S. General Accounting Office (GAO) that found the government has paid $2.7 trillion in fraudulent claims since 2003. Though substantial at $2.7 trillion, these cumulative fraudulent disbursements occurred over two decades across Democrat and Republican administrations.

The federal government disbursed the highest levels of fraudulent payments in 2020 and 2021 while attempting to prevent the economy from falling into a deep recession after being shut down. I will leave it to the reader to decide whether closing the economy was prudent.

Interestingly, the GAO found that these fraudulent disbursements were widespread. In 2023, improper payments were issued through Medicare, Medicaid, unemployment insurance programs, the Small Business Paycheck Protection Program, the Federal Earned Income Tax Credit, and Social Security’s Supplemental Security Income program.

Unsurprisingly, fraudulent government payments surged sharply between 2020 and 2021, coinciding with the government's extensive relief programs launched to address the economic shutdown caused by the global pandemic. In response to this shutdown, the Federal Reserve injected approximately $5 trillion in monetary stimulus, while the Federal Government allocated another $5 trillion in fiscal stimulus. Such rapid and large-scale financial interventions created a fertile environment for fraud and inefficiencies, yet they still failed to demonstrate a direct link between budget deficits and inflation.

Summary and Concluding Thoughts

While wasteful government spending and high deficits should be permanently eliminated to improve efficiency and fiscal responsibility, historical data do not support the argument that the current high inflation is directly attributable to the high 2024 budget deficit.

Our readers are free to debate whether the infrastructure bill to repair our bridges and tunnels was wasteful or the spending to rebuild our domestic semiconductor chip industry was ill-advised. Still, the data does not support the argument that those expenditures, on their own, caused the inflation surge. The rise in inflation may have happened because the economy was too robust to absorb such spending when the U.S. was dealing with inflationary pressures arising from supply chain disruptions and excessively loose monetary policies. These developments created an inflationary cocktail that has continued to spread its adverse effects well into 2025. Of course, accusations of overstimulating an already overheated economy contradict many claims that the U.S. economy was entrenched in a recession from 2021 to 2024, even if conventional economic metrics failed to support that view.

The weak 4.7% correlation between the PCE inflation rate and federal deficits over many decades suggests that other factors—such as supply shocks, monetary policy, and global economic trends—play a much more significant role in determining inflation.

Policymakers should always prioritize reducing waste and fraud in government spending. However, we must avoid oversimplifying the complex causes of inflation by assuming that large federal budget deficits are the primary drivers of inflation. Undoubtedly, both sides of the political aisle can agree that U.S. deficits are unsustainable and detrimental to the economy in the long run. Nevertheless, this should not justify using the deficit as a scapegoat for our current inflation issues. While the government deficit may have been a contributing factor, it is just one of many factors that led us toward higher inflation!